OTC derivatives clearing

1. Joint Bank of England / ECB Conference on
‘Payments and monetary and financial stability’
12-13 November 2007
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©LCH.Clearnet Group Limited
Simon Grensted
Managing Director, Business Development
LCH.Clearnet
Panel Session:
OTC derivatives clearing arrangements

2. www.lchclearnet.com
©LCH.Clearnet Group Limited
Slide 2
Derivative Market Size & Growth
Some clues to where new clearing products are likely to emerge
However, clearing is only feasible if the multilateral risks can be managed
1 10 100 1,000
$ trillion outstanding notional
10%
1%
100%
200%
CAGR
%
CDS Multi-Name
Equity Fund & Swaps
CDS Single Name
Gold
FX Futures & Options
EQ Options
FRA Interest Rate Options
FX Spot & Forward
IR F&O
IRS
Cross Currency Swaps
Equity Futures & Options
FX Options
OTC
Exchange Traded
Commodity
Key factors:
• Size
• Growth
• Liquidity
• Vanilla
• Multilateral
adoption
• STP
• Messaging
• Price
sources
• Potential to
backload
• Ability to
auction a
defaulter’s
portfolio

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Slide 3
SwapClear notionals
Notionals have grown in line with the market; we were told it would be
too complex, not feasible, it is not, others will follow…
Cumulative Trade Sides Cleared / Notional Outstanding (sides)
0
20
40
60
80
100
120
2001-01
2001-04
2001-07
2001-10
2002-01
2002-04
2002-07
2002-10
2003-01
2003-04
2003-07
2003-10
2004-01
2004-04
2004-07
2004-10
2005-01
2005-04
2005-07
2005-10
2006-01
2006-04
2006-07
2006-10
2007-01
2007-04
2007-07
2007-10
Notional
(Trillion
$)
0
100,000
200,000
300,000
400,000
500,000
600,000
700,000
800,000
900,000
Cumulative
number
registered
trade
sides
$ Notional Trade Sides Total
Size (October 07): $103trillion
Circa $3trillion per month
STP : ~89% in T+0 or T+1

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Slide 4
STP is a key benefit
SwapClear is an STP only system, manual intervention is for exceptions only; we
got there through rigorous multilateral implementation and testing.
3546
4465
34313
2204
2391
16254
451
520
3098
238 371
1295
304
606
2056
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
Trades
T+0 T+1 T+2 T+3 >T+3
Bucket
07 09 Sep
07 08 Aug
TOTAL YTD

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©LCH.Clearnet Group Limited
Slide 5
What makes OTC clearing worth doing but difficult?
Benefits
• Clearing offers a highly scalable processing environment, everyone is bound to a consistent model
• Multilateral netting brings improvements over bilateral netting
• Collateral and guarantee arrangements save Credit Capital and Basle II regulatory capital
• Strong business case for user adoption and clearing houses to build services.
Its not that easy
• Many OTC services are really about clearing off exchange trades (particularly energy and equities
derivatives).
• Pricing illiquid trades eg out of the money options
• The real OTC world is divided into many shapes and sizes
• Real OTC trades can be very complex.
• Clearing works for the volume/vanilla trades
• Now imagine a portfolio of complex trades.
•Some illiquidity
•Price dislocations
•Concentration risks
• LTCM and other defaults have moved the industry forward in learning about defaults and how to
manage them
• Pricing trades, then portfolios is vital to risk management.
• Multilateral risk introduces new problems to solve
• LCH.Clearnet has taken a conservative (services are not open to all) and industry partnership approach
to default management

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©LCH.Clearnet Group Limited
Slide 6
GCM
GCM GCM
GCM
Clearing Membership Structures
General Clearing Members are vital to LCH.Clearnet’s credit risk intermediation. The
model is more complex when you look at the GCM structures and organisations

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Slide 7
BANK
TRADING BANK
SUB
BANK
SUB RELATED BANK SUBS
ACCESSING CLEARING
DIRECTLY
GCM
&
TRADER
SUB
BANK
GCM
&
TRADER
TRADING OWN BOOK
AND OFFERING SERVICES
TO SUBS
GCM
SUB
CLIENT
TRADER
CLIENT
TRADER
CLIENT
TRADER
CLIENT
TRADER
CLIENT
TRADER
CLIENT
TRADER
GCM OFFERING
GLOBAL CLEARING FACILITIES
BANK SUB
OFFERING GCM SERVICES
TYPE A
TYPE B
TYPE D
TYPE C
Clearing Membership Structures
GCMs carry the risk of their client defaulting. LCH.Clearnet has different
structures across markets
Futures OTC

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Slide 8
IRS Notional distributions
It is a highly concentrated market, 86% of the total in 38 banks with
portfolios of more than $1trillion
0
10000
20000
30000
40000
50000
60000
1
3
5
7
9
11
13
15
17
19
21
23
25
27
29
31
33
35
37
NP Billions
per bank
Banks
ranked by
NP down to
$1T
65% of total
notional in top
10

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Slide 9
What next?
Standards in post trade infrastructure
• Convergence with the DTCC warehouse
• More work to be planned out between our working groups
• Ultimately we would like to see consistent layered models where processes
are consistent and services can be implemented consistently across abroad
range of derivatives
• First step
• Deriv/SERV interface for IRS trades into SwapClear

10. www.lchclearnet.com
©LCH.Clearnet Group Limited
Slide 10
LCH.Clearnet Contacts
London
Porto
Paris
Brussels
Amsterdam
Simon Grensted
Managing Director,
Business Development
+ 44 (0)20 7426 7066
simon.grensted@lchclearnet.com